A lot of time has been spent discussing the recent financial crisis and its impact on the cement sector. The pre-crisis strategic drivers and behaviour of the sector have changed significantly in the post-crisis era. How can cement businesses proceed from here...?
In the view of Cement Business Advisory (CBA), the drivers and behaviour before and after the global economic crisis developed as shown in Table 1. But what has been happening in the past five years..?
Pre-crisis | During crisis (2009 - 10) | Post crisis |
Additional capacity | Preservation of free cash flow | Cyclical recovery |
Increased leverage | Debt reduction | Continued focus on financial performance |
Excessive mergers and acquisitions | Revenue-driven cost-cutting initiatives | Improve market structure and dynamics |
Effective cash management |
Above - Table 1: Strategic drivers for cement producers have seen three distinct periods in the past decade.
Geopolitical issues
As the financial crisis appeared to be ebbing away, the world has experienced some significant geopolitical events. This article is not intended to provide a definitive listing of all relevant events but to offer a flavour of what has happened and how the sector has been influenced by such events. Some significant events were:
1. The Arab Spring, which led to significant changes to the status quo in many Arab countries. This has led to unsettling issues such as the Syria situation, Libya, Yemen and other related events in Egypt, Tunisia and other locations. These events may have been exacerbated by low oil prices which resulted in reduced revenues in many Gulf States and the influx of significant numbers of refugees to ‘safe havens’ such as Lebanon, Jordan, Turkey and Europe. The uncertainty and retrospection in many countries in this region are now palpable.
2. The annexation of parts of Ukraine by Russia was another event that destabilised and unsettled the status quo. This was followed by sanctions from the west and the re-animation of a stand-off between Russia and ‘the rest’ reminiscent of bygone eras.
3. In the meantime, Western economies have shown signs of tiredness and stagnation. The post-crisis period of 2010 to 2016 has left many western people questioning the benefits of globalisation motivated by stubbornly static economies, particularly in Europe, and increasing disparities between the so-called ‘elite’ and the rest. The EU GDP has grown at an average 1.2%/yr from 2010 to 2016.
2016 proved to be an eventful year… First, came the UK vote to leave the European Union, sending waves of turbulence towards Europe and beyond. The (for many) unlikely victory of Donald Trump, and his propensity to topple a number of hitherto established understandings topped the year. Terrorist atrocities in France, Belgium, Germany and the UK have unsettled many Western Europeans and as a result Europe found itself with closed borders and walls being erected between member states of the EU.
4. Other destabilising events in the post-crisis era have taken place in Turkey, Venezuela, sub-Saharan Africa and many other countries, increasing the level of uncertainty and confusion.
Cement sector specific issues
In the wake of such a tumultuous geopolitical environment, the global cement sector has contributed its fair share to increasing the uncertainty and wariness of professionals operating in the industry.
The two mega mergers (LafargeHolcim and Heidelberg’s purchase of Italcementi) were affected in the post-crisis era by executing what were, to that point, ‘unthinkable’ unions. The benefits and value of these two transactions are subject to numerous analytical comments and I will not indulge in my own views and opinions in this article. However the impact on the fibre of the industry is unmistaken. The supremacy of the major international players was under threat and the atmosphere in many cement companies was one of confusion and questioning.
One of the main arguments behind these mega-mergers was the further consolidation of the global cement sector. In fact, the opposite may be true. The notion that increased capacity ownership by one or two players increases the sector consolidation is flawed. It is estimated that the top seven international producers held around 16% of global cement capacity in 2012 whereas currently the top seven hold below 15%. Not a meaningful impact here. At the same time, there were new entrants in many markets in the Middle East, Africa, Central Asia and South East Asia. CBA would argue that, despite the mega mergers, more individual markets fragmented than consolidated between 2012 and 2017, particularly in developing regions. It could be argued that the structures of individual markets provide a more meaningful measure of sector consolidation.
On the other hand, the pre-crisis propensity to add new capacity has continued almost unabated. Although most international players, either due to financial constraints or chosen strategy, did not participate in new capacity additions, many new entrants appeared in a number of markets, asserting their claim on what was perceived to be a lucrative sector of the economy. It is estimated that capacity rose from 4.4Bnt/yr in 2010 to 5.8Bnt/yr in 2016 (a rise of 1.4Bnt), whereas demand increased by 1.0Bt over the same period, from 3.3Bnt/yr to 4.3Bnt/yr.
Impact on the cement sector
The combined geopolitical events and sector specific issues have impacted the sector significantly. In the period between 2008 and 2013, the sector experienced a significant cyclical recovery, with cement demand growing at a rate of around 7%/yr. However, since 2013 the global cement sector has grown at around 2%/yr. The cyclical recovery has therefore stalled, perhaps due to the geopolitical events.
As a result of this and the continuing capacity additions, the sector is currently faced with an unattractive supply-demand balance globally. It is estimated that global capacity utilisation rates currently stand at around 70%.
In addition, the slowing of the Chinese economy and the perceived negative impact on many emerging economies of the ‘rejection’ of globalisation does not bode well for the tightening of the supply-demand balance going forward. The Chinese economic deceleration is reflected in the cement consumption statistics. Between 2008 and 2013 cement demand grew in China by around 12%/yr, whereas between 2013 and 2016 it only grew by around 1.5%/yr. Added to this, increased climate change legislation and tighter environmental requirements have introduced additional strains on the sector.
What is the sector to do?
It is nigh on impossible to define a strategy for a whole sector. Strategy is developed and implemented by individual players within the sector. So, what could a committed cement player do in the face of such a challenging environment?
Truly consolidate: There are many markets globally that have an unsustainably high number of participants. In many, culture, legislation and funding are not yet in place to allow for meaningful consolidation initiatives. This can change but requires effort from committed players.
Move to a sustainably lower cost base: This may sound like stating the obvious, but it is not. It is surprising how much improvement an average cement producer can achieve both at plant level but also in the rest of its operations CBA’s experience suggests that there isn’t a cement plant in the world that cannot improve its cost structure further. I am sure many would now think ‘but our plant is new and very efficient.’ Again, we would challenge this position and can prove that improvements are possible, even in the newest of plants
Also, in recent years, low oil prices have impacted energy costs in the cement sector and supported attractive financial performances, perhaps leading producers into a false sense of security. This could easily be reversed when oil prices rise.
Turning to operations, it is also surprising to see that many cement producers rarely focus on improving their operational structure to improve costs and address the changing operating environment. The definition and development of an attractive distribution chain is one example in many developing markets where cement producers may miss opportunities to define a more robust business model. There are significant levels of introspection and complacency to be found across the global cement industry. Moving to a sustainably lower cost base is fundamental for leading cement players in order for them to cope with overcapacity and fragmentation.
Optimise investment costs: This refers to both the cost and funding efficiency of all investment projects. It is baffling to see cement project costs escalating given the current situation. This reflects on: 1. The cement producers’ ability to manage their project efficiently and; 2. The propensity of project suppliers (equipment manufacturers, construction companies, et al.) to present cement investments as special projects tantamount to ‘Rocket Science!’ This view could be disputed.
Funding a cement-related project is also an area where a more efficient approach may be taken. Cement manufacturers need to open up their funding sources to more than the local banks, and try to achieve the best possible financial outcome for their investment. The benefits that a local or regional cement producer could attain by approaching alternative funding institutions, including development finance institutions, private equity houses, international commercial institutions, surpass the commercial terms of a loan or an equity stake.
Address capacity utilisation issues: When all is said and done, the unattractive supply-demand balance leads to lower capacity utilisation rates for cement plants. This is bad news, as the cost structure of a cement plant dictates the necessity for full capacity utilisation: the ‘Holy Grail’ of cement economics. In situations like this, we have seen too many market share ‘fights’ in domestic markets that result in reduced prices and, invariably, insignificant changes in volumes. So, what other options are there for a cement producer to improve capacity utilisation rates?
Exports
In the pre-crisis era, when cement was scarce, many producers found it quite easy to export excess volumes to various deficit markets. This, sadly, is not the case anymore. CBA has argued on many occasions that opportunistic exporting is all but defunct. CBA has also argued that developing and sustaining a long-term export strategy for many low capacity utilisation producers is a compelling strategic requirement.
Our thesis is that, an export strategy must include (beyond the standard aspects of relevant product, product licensing in destination markets, logistics expertise etc.) a commitment to the destination markets in terms of assets on the ground. These may include terminals, grinding stations, bagging plants and even Readymix concrete assets.
It is common to spot announcements in the global cement news of new plants being erected with ‘exports in mind.’ It is less common to see a referral to an export strategy in these announcements. Even later, when the capacity comes on stream, we have seen frantic attempts of many plants to move product to deficit markets, which are disappearing as we speak, on an opportunistic / spot-pricing basis. As a result, competition in cement/clinker trading has intensified and FOB prices are very subdued.
It may be beyond anyone’s financial expertise to be able to justify a US$250m asset with, say 1.5Mt/yr of capacity, when FOB prices are in the region of US$30-40/t, and the plant has been erected with ‘exports in mind.’ It is sometimes baffling to see new entrants (invariably from other sectors of the economy) exhibit such inadequate understanding of the economics of cement.
Vertical Integration
We have on many occasions in the past spoken about vertical integration (VI), the idea of common ownership of cement and other downstream assets, including Readymix concrete, concrete products and others. Again, this requires diligent analysis and implementation strategy if the decision to go ahead with VI is taken.
There are many elements that need to be considered in order to decide that VI is a sound strategy. These elements differ significantly from one geography to another. They require local knowledge and careful consideration. An understating of the trends and future development of the construction industry is essential. Our experience in this area is extensive, and it leads us to believe that there cannot be a universal VI strategy, as is the view of some international cement players. It would instead require a market-by-market approach.
Removal of capacity
Easier said than done? Perhaps, although there have recently been such moves in western Europe. This is a more difficult concept for developing markets to grasp. Indeed, it may not be appropriate for many such markets. However, even in developing regions, there are some markets that would benefit from some capacity removal, particularly if significant inefficient, high cost supply exists. China and Russia are two examples here. It is estimated that, since the financial crisis, only western and central Europe removed cement capacities whereas North America remained static. The rest of the world’s regions have added capacity.
Removing capacity properly, i.e. not mothballing kilns but removing them completely, is not an easy task in many regions and requires careful planning, with strict adherence to local legislation.
Conclusions
In conclusion, it appears that the global cement sector is influenced by both the turbulent geopolitical environment and sector specific issues. Careful planning and implementation is required to address this environment for a cement company to survive and thrive. Here, we described some options that cement producers have in order to improve their current situation. Clearly, an overall strategy should include other growth initiatives such as potential entry into new markets and corporate development (acquisitions and disposals). We leave these aspects of strategy for a future article.